Dynamic behavior of hydro/thermal electrical operators under an environmental policy targeting the preservation of ecosystem integrity and air quality

In this paper, we analyze the effect of an environmental policy targeting the enhancement of ecosystem integrity as well as air quality in the wholesale electricity market. We develop a dynamic Cournot game featuring two risk-averse electricity producers – one hydro and one thermal – under demand uncertainty. We demonstrate that while improving air quality necessarily raises the market price, enhancing ecosystem integrity can, under the water-abundance hypothesis, reduce it. Moreover, in order to establish a statement about the environmental policy's efficiency, we examine interactions between these environmental measures and their potential side effects. We show that prioritizing a natural flow regime minimizes the taxation efficiency of lowering air pollution and emphasizes the price rise due to taxation. Nevertheless, the effect of the taxation policy on the efficiency of the ecosystem integrity policy depends on the hydro producer's ability to substitute thermal units. In order to establish a precise environmental statement, regulation authorities need to compare, using appropriate criteria, the importance of an avoided unit of surrounding ecosystem alteration with the importance of an avoided unit of air-polluting production in the functioning of the whole ecosystem.